Where are we on holiday pay?

Paul Maynard, Employment Law Partner, provides an update on the constantly shifting question of what should be included in the calculation for holiday pay.

There have been no fewer than ten separate court judgments on the question of how to calculate holiday pay in recent years. In many cases, decisions that were thought to have settled the law have been overturned on appeal. It is little wonder that employers continue to get the calculation of holiday pay wrong and leave themselves exposed to claims for substantial amounts of back pay. These liabilities often arise as part of a wider employment dispute or, occasionally, when an employer goes through due diligence as a necessary part of the sale of the business.

Most of the complexities arise where a worker’s pay is variable, for example, where they receive commission, allowances or regularly work overtime. The situation is, however, a little clearer following a decision of the Court of Appeal last week although still questions remain.

Workers’ entitlement to statutory holiday pay is derived from two separate sources. The European Working Time Directive (Directive) gives workers the right to at least four weeks (20 days) paid annual leave. The right to an additional 8 days paid holiday is derived from domestic legislation in the form of the Working Time Regulations 1988 (Regulations). This distinction is important because the case law on the interpretation of the Directive does not necessarily apply to the Regulations. In other words, different tests may apply to the calculation of holiday pay in respect of the 20 days’ entitlement under the Directive than to the additional 8 days under the Regulations. A further complexity is that any holiday entitlement beyond the statutory 28 days is entirely governed by the wording of the contract of employment.

The most recent case, brought by employees of the Ambulance Service in the East of England, concerns their entitlement to have both compulsory but non-guaranteed overtime and voluntary overtime included in the calculation of holiday pay. The Ambulance Service had not included any overtime when it calculated the amount of holiday pay for its staff.

Compulsory non-guaranteed overtime usually arose where staff were engaged in emergency calls towards the end of a shift which then overran. The Court of Appeal had little hesitation in concluding that where a worker is obliged to perform overtime, then payment for it during the relevant reference period should always be included within the holiday pay calculation.

The Appeal Court applied a different test in relation to voluntary overtime, where the staff had been completely free to choose whether or not to work additional shifts. In this scenario, the legal test was whether voluntary overtime counts as “normal remuneration”. The court found that elements of pay which are sufficiently regular or recurring qualify as “normal” and if overtime is normally worked, it should not be excluded merely because it is voluntary. What amounts to “normal” is a matter of fact and degree but if overtime is worked every week or every month then it should be taken into account.

This ruling only applies to the 20 days’ leave under the Directive and not to the additional 8 days annual leave under the Regulations, in the same way that the right to accrued holiday during long-term sick leave only applies to the 20 days under the Directive and not to the additional 8 days under the Regulations. However, whether it is feasible and proportionate for employers to apply both methodologies to the calculation of holiday pay remains to be seen. Certainly, it would be worthwhile doing so for employers with large work forces with variable rates of pay. In such a case, it is advisable to make a distinction between holiday pay under the Directive and under the Regulations in the contract of employment.

These principles apply to all forms of remuneration, not just overtime. The European Court of Justice has already ruled that commission must be included in the calculation for holiday pay as it is intrinsically linked to the performance of tasks under the workers’ contract. It is not enough to simply pay in arrears commission which has been earned during holiday periods but rather the employer has to remove the financial disadvantage suffered by the employee from being on holiday and as a result not being able to earn commission during that time. Many employers with sales staff, particularly car dealerships and estate agencies, are waking up to this reality, but many have still not.

It is also important for employers to recognise the subtle distinction between payment of allowances and payment of expenses. Expenses which reimburse workers for costs incurred in performing their duties, such as travel or subsistence, are excluded from the calculation of holiday pay.

Some allowances, however, are not intended to exclusively cover occasional or ancillary costs and are more akin to a bonus for performing certain tasks or performing them under certain conditions or at certain times. Time spent by workers travelling to different sites, as is common in the construction industry, is more in the form of an allowance than an expense and should be included within the holiday pay calculation.

Night shift and sleep-in allowances, standby and emergency call out payments and productivity, attendance and performance bonuses have all recently been found to amount to “normal remuneration” which is intrinsically linked to the performance of duties and which should be included within the calculation of holiday pay. On the other hand, annual bonuses, particularly if they are linked to the performance of the employer rather than the individual are less likely to fall within the scope of “normal remuneration” although this remains something of a grey area.

Having established that compulsory and regularly worked overtime, commission, allowances, shift and stand-by payments and performance related bonuses should all be included within the holiday pay calculation, the question arises as to what is the current reference period for averaging pay? The default position is that holiday pay is based on average pay over the preceding 12 week period and this will apply unless it does not reflect the reality of the situation – for example, where the variable element of pay is seasonal. Employers should note that legislation planned for April 2020 is likely to impose a 12 month reference period, in most cases.

The single bit of good news for employers is that since 2015 claims for arrears of pay, including holiday pay, in the employment tribunal have been limited to a two year backstop.

For advice on any employment law matter contact Paul Maynard.

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